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Chapter 05 - AuditEvidenceand Documentation Chapter 05AuditEvidenceand Documentation True / False Questions The professional standards consider calculating depreciation expense a "routine" transaction True False The most reliable form of documentary evidence generally is considered to be documents created by the client True False A vendor's invoice is an example of documentary evidence created by a third party and held by the client True False In performing analytical procedures, the auditors may use dollar amounts, physical quantities, or percentages True False The primary purpose of a letter of representations is to obtain additional evidence about specific accounts True False The auditors should propose an adjusting journal entry for all material related-party transactions True False 5-1 Chapter 05 - AuditEvidenceand Documentation When the risk of material misstatement for an account is high, the auditors may perform additional substantive procedures to restrict detection risk to a lower level True False Working papers of continuing audit interest usually are filed with the administrative working papers True False The use of lead schedules is designed to increase the detail of the working trial balance True False 10 Adjusting journal entries are ordinarily recorded by the client, while reclassifying journal entries need not be recorded True False Multiple Choice Questions 11 To be effective, analytical procedures in the overall review stage of an audit engagement should be performed by A The staff accountant who performed the substantive auditing procedures B A beginning staff accountant who has had no other work related to the engagement C A manager or partner who has a comprehensive knowledge of the client's business and industry D The CPA firm's quality control manager 5-2 Chapter 05 - AuditEvidenceand Documentation 12 The components of the risk of misstatement are: A Option A B Option B C Option C D Option D 13 Financial statement assertions are established for classes of transactions, A Option A B Option B C Option C D Option D 14 Which of the following is correct concerning a "fraud risk factor"? A It may affect the auditor's assessment of fraud risk B It requires modification of planned audit procedures C It is also a material weakness in internal control D If it involves senior management, it is likely to result in resignation of the auditor 15 When performing a financial statement audit, auditors are required to explicitly assess the risk of material misstatement due to: A Fraud B Misappropriation C Illegal Acts D Business risk 5-3 Chapter 05 - AuditEvidenceand Documentation 16 As planning materiality is decreased, the auditor should plan more work on individual accounts to A Find smaller misstatements B Find larger misstatements C Increase the tolerable misstatement in the accounts D Decrease the risk of assessing control risk too low 17 Further audit procedures include: A Option A B Option B C Option C D Option D 18 Assertions that have a meaningful bearing on whether an account balance, transaction class or disclosure is fairly stated are referred to as: A Appropriate assertions B Sufficient assertions C Relevant assertions D Reliable assertions 19 Which of the following is not an assertion relating to classes of transactions? A Accuracy B Sufficiency C Cutoff D Classification 5-4 Chapter 05 - AuditEvidenceand Documentation 20 Which of the following is required documentation in an audit? A A written engagement letter formalizing the level of services to be provided B A flowchart of the client's organization C A written audit program D A memo setting forth the scope of the audit 21 Which of the following is not considered to be an analytical procedure? A Comparisons of financial statement amounts with source documents B Comparisons of financial statement amounts with nonfinancial data C Comparisons of financial statement amounts with budgeted amounts D Comparisons of financial statement amounts with comparable prior year amounts 22 An auditor plans to apply substantive tests to the details of asset and liability accounts as of an interim date rather than as of the balance sheet date The auditor should be aware that this practice A Eliminates the use of certain statistical sampling methods that would otherwise be available B Presumes that the auditor will reperform the tests as of the balance sheet date C Should be especially considered when there are rapidly changing economic conditions D Potentially increases the risk that errors that exist at the balance sheet date will not be detected 23 An auditor compared the current-year gross margin with the prior-year gross margin to determine if cost of sales is reasonable What type ofaudit procedure was performed? A Testof transactions B Analytical procedures C Testof controls D Testof details 24 The inspection of a vendor's invoice by the auditors is: A Direct evidence about occurrence of a transaction B Physical evidence about occurrence of a transaction C Documentary evidence about occurrence of a transaction D Part of the client's accounting system 5-5 Chapter 05 - AuditEvidenceand Documentation 25 The auditors of Smith Electronics wish to limit the audit risk of material misstatement in the testof accounts receivable to percent They believe that inherent risk is 100%, and there is a 40% risk that material misstatement could have bypassed the client's system of internal control What is the maximum detection risk the auditors should specify in their substantive procedures of details of accounts receivable? A 5% B 12.5% C 42.7% D 60% 26 Analytical procedures are required at the planning stage of all audits and as: A Tests of internal control B Substantive procedures C A part of the final overall review D Computer generated procedures 27 During financial statement audits, auditors seek to restrict which type of risk? A Control risk B Detection risk C Inherent risk D Account risk 28 Which of the following groups are not considered a specialist by AICPA Professional Standards: A Appraisers B Internal auditors C Engineers D Geologists 29 CPA wishes to use a representation letter as a substitute for performing otheraudit procedures Doing so: A Violates professional standards B Is acceptable, but should only be done when cost justified C Is acceptable, but only for non-public clients D Is acceptable and desirable under all conditions 5-6 Chapter 05 - AuditEvidenceand Documentation 30 Which of the following best describes the problem with the use of published industry averages for analytical procedures? A Lack of comparability B Lack of sufficiency C Lack of accuracy D Lack of availability 31 In auditing an asset valued at fair value, which of the following potentially provides the auditor with the strongest evidence? A A price for a similar asset obtained from an active market B An appraisal obtained discounting future cash flows C Management's judgment of the cost to purchase an equivalent asset D The historical cost of the asset 32 An auditor should expect that fair value is the price that would be received to sell an asset in an orderly transaction between the market participants at the: A Acquisition date of the asset B Audit report date C Expected replacement date of the asset D Measurement date (ordinarily the date of the financial statements) 33 Which of the following best describes the reason that auditors are concerned with the detection of related party transactions? A The financial statements must often be adjusted for the effects of material related party transactions B Material related party transactions must be disclosed in the notes to the financial statements C The substance of related party transactions will differ from their form D In a related party transaction one party has the ability to exercise significant influence over the other party 5-7 Chapter 05 - AuditEvidenceand Documentation 34 Which of the following is not a basic procedure used in an audit? A Risk assessment procedures B Substantive procedures C Tests of controls D Tests of direct evidence 35 Which of the following is not a financial statement assertion relating to account balances? A Completeness B Existence C Rights and obligations D Valuation and allowances 36 Which of the following is generally true about the sufficiency ofaudit evidence? A The amount ofevidence that is sufficient varies inversely with the risk of material misstatement B The amount ofevidence concerning a particular account varies inversely with the materiality of the account C The amount ofevidence concerning a particular account varies inversely with the inherent risk of the account D When evidence is appropriate with respect to an account it is also sufficient 37 Which of the following is true about analytical procedures? A Performing analytical procedures results in the most reliable form ofevidence B Analytical procedures are tests of controls used to evaluate the quality of a client's internal control C Analytical procedures are used for planning, but they should not be used to obtain evidence as to the reasonableness of specific account balances D Analytical procedures are used in planning, as a substantive procedure for specific accounts, and in the final review of the audited financial statements 5-8 Chapter 05 - AuditEvidenceand Documentation 38 Which of the following is a basic approach often used by auditors to evaluate the reasonableness of accounting estimates? A Confirmation B Observation C Reviewing subsequent events or transactions D Analyzing corporate organizational structure 39 An auditor is performing an analytical procedure that involves comparing a client's account balances over time This technique is referred to as: A Vertical analysis B Horizontal analysis C Cross-sectional analysis D Comparison analysis 40 An auditor is performing an analytical procedure that involves comparing a client's ratios with other companies in the same industry This technique is referred to as: A Vertical analysis B Horizontal analysis C Cross-sectional analysis D Comparison analysis 41 An auditor is performing an analytical procedure that involves developing common-size financial statements This technique is referred to as: A Vertical analysis B Horizontal analysis C Cross-sectional analysis D Comparison analysis 42 Which of the following is not a basic approach often used by auditors to evaluate the reasonableness of accounting estimates? A Confirmation of amounts B Review of management's process of development C Independent development of an estimate D Review of subsequent events 5-9 Chapter 05 - AuditEvidenceand Documentation 43 The audit time budget is an example of: A A supporting schedule B An administrative working paper C A lead schedule D A corroborative working paper 44 A schedule set up to combine similar general ledger accounts, the total of which appears on the working trial balance as a single amount, is referred to as a: A Supporting schedule B Lead schedule C Corroborating schedule D Reconciling schedule 45 Which of the following is not a function of working papers? A Provide support for the auditors' report B Provide support for the accounting records C Aid partners in planning and conducting future audits D Document staff compliance with generally accepted auditing standards 46 A schedule listing account balances for the current and previous years, and columns for adjusting and reclassifying entries proposed by the auditors to arrive at the final amount that will appear in the financial statement, is referred to as a: A Working trial balance B Lead schedule C Summarizing schedule D Supporting schedule 47 The auditors use analytical procedures during the course of an audit The most important phase of performing these procedures is the: A Vouching of all data supporting various ratios B Investigation of significant variations and unusual relationships C Comparison of client-computed statistics with industry data on a quarterly and full-year basis D Recalculation of industry date 5-10 Chapter 05 - AuditEvidenceand Documentation 38 Which of the following is a basic approach often used by auditors to evaluate the reasonableness of accounting estimates? A Confirmation B Observation C Reviewing subsequent events or transactions D Analyzing corporate organizational structure Difficulty: Hard 39 An auditor is performing an analytical procedure that involves comparing a client's account balances over time This technique is referred to as: A Vertical analysis B Horizontal analysis C Cross-sectional analysis D Comparison analysis Difficulty: Easy 40 An auditor is performing an analytical procedure that involves comparing a client's ratios with other companies in the same industry This technique is referred to as: A Vertical analysis B Horizontal analysis C Cross-sectional analysis D Comparison analysis Difficulty: Easy 41 An auditor is performing an analytical procedure that involves developing common-size financial statements This technique is referred to as: A Vertical analysis B Horizontal analysis C Cross-sectional analysis D Comparison analysis Difficulty: Easy 5-30 Chapter 05 - AuditEvidenceand Documentation 42 Which of the following is not a basic approach often used by auditors to evaluate the reasonableness of accounting estimates? A Confirmation of amounts B Review of management's process of development C Independent development of an estimate D Review of subsequent events Difficulty: Medium 43 The audit time budget is an example of: A A supporting schedule B An administrative working paper C A lead schedule D A corroborative working paper Difficulty: Easy 44 A schedule set up to combine similar general ledger accounts, the total of which appears on the working trial balance as a single amount, is referred to as a: A Supporting schedule B Lead schedule C Corroborating schedule D Reconciling schedule Difficulty: Easy 45 Which of the following is not a function of working papers? A Provide support for the auditors' report B Provide support for the accounting records C Aid partners in planning and conducting future audits D Document staff compliance with generally accepted auditing standards Difficulty: Easy 5-31 Chapter 05 - AuditEvidenceand Documentation 46 A schedule listing account balances for the current and previous years, and columns for adjusting and reclassifying entries proposed by the auditors to arrive at the final amount that will appear in the financial statement, is referred to as a: A Working trial balance B Lead schedule C Summarizing schedule D Supporting schedule Difficulty: Easy 47 The auditors use analytical procedures during the course of an audit The most important phase of performing these procedures is the: A Vouching of all data supporting various ratios B Investigation of significant variations and unusual relationships C Comparison of client-computed statistics with industry data on a quarterly and full-year basis D Recalculation of industry date Difficulty: Medium 48 The auditors must obtain written client representations that normally should be signed by: A The president and the chairperson of the board B The treasurer and the internal auditor C The chief executive officer and the chief financial officer D The corporate counsel and the audit committee chairperson Difficulty: Easy Source: AICPA 49 Which of the following ultimately determines the specific audit procedures necessary to provide independent auditors with a reasonable basis for the expression of an opinion? A The audit time budget B The auditors' judgment C Generally accepted accounting quality standards D The auditors' working papers Difficulty: Easy Source: AICPA 5-32 Chapter 05 - AuditEvidenceand Documentation 50 Failure to detect material dollar errors in the financial statements is a risk which the auditors primarily mitigate by: A Performing substantive procedures B Performing tests of controls C Assessing control risk D Obtaining a client representation letter Difficulty: Easy Source: AICPA 51 An independent auditor finds that the Simmer Corporation occupies office space, at no charge, in an office building owned by a shareholder This finding indicates the existence of: A Management fraud B Related party transactions C Window dressing D Weak internal control Difficulty: Medium Source: AICPA 52 Which of the following would not necessarily be considered a related party transaction? A Payment of a bonus to the president B Purchases from another corporation that is controlled by the corporation's chief stockholder C Loan from the corporation to a major stockholder D Sale of land to the corporation by the spouse of a director Difficulty: Easy Source: AICPA 53 The date of the management representation letter should coincide with the: A Date of the auditor's report B Balance sheet date C Date of the latest subsequent event referred to in the notes to the financial statements D Date of the engagement agreement Difficulty: Medium Source: AICPA 5-33 Chapter 05 - AuditEvidenceand Documentation 54 An example of an analytical procedure is the comparison of: A Financial information with similar information regarding the industry in which the entity operates B Recorded amounts of major disbursements with appropriate invoices C Results of a statistical sample with the expected characteristics of the actual population D EDP generated data with similar data generated by a manual accounting system Difficulty: Medium Source: AICPA 55 When considering the use of management's written representations as auditevidence about the completeness assertion, an auditor should understand that such representations: A Complement, but not replace, substantive procedures designed to support the assertion B Constitute sufficient evidence to support the assertion when considered in combination with a moderate assessed level of control risk C Are generally sufficient auditevidence to support the assertion regardless of the assessed level of control risk D Replace the assessed level of control risk as evidence to support the assertions Difficulty: Medium Source: AICPA 56 Which of the following expressions is least likely to be included in a client's representation letter? A No events have occurred subsequent to the balance sheet date that require adjustment to, or disclosure in, the financial statements B The company has complied with all aspects of contractual agreements that would have a material effect on the financial statements in the event of noncompliance C Management acknowledges responsibility for illegal actions committed by employees D Management has made available all financial statements, including notes Difficulty: Medium Source: AICPA 5-34 Chapter 05 - AuditEvidenceand Documentation 57 Which of the following statements is generally correct about audit evidence? A The auditor's direct personal knowledge, obtained through observation and inspection, is more persuasive than information obtained indirectly from independent outside sources B To be appropriate, auditevidence must be sufficient C Accounting data alone may be considered sufficient appropriate auditevidence to issue an unqualified opinion on financial statements D Appropriateness ofauditevidence refers to the amount of corroborative evidence to be obtained Difficulty: Easy Source: AICPA 58 Which of the following statements relating to auditevidence is the most accurate statement? A Auditevidence gathered by an auditor from outside an enterprise is reliable B Accounting data developed under satisfactory conditions of internal control are more relevant than data developed under unsatisfactory internal control conditions C Oral representations made by management are not valid evidence D The auditor must obtain sufficient appropriate auditevidence Difficulty: Easy Source: AICPA 59 Which of the following is not a typical analytical procedure? A Study of relationships of the financial information with relevant nonfinancial information B Comparison of the financial information with similar information regarding the industry in which the entity operates C Comparison of recorded amounts of major disbursements with appropriate invoices D Comparison of the financial information with budgeted amounts Difficulty: Medium Source: AICPA 5-35 Chapter 05 - AuditEvidenceand Documentation 60 Which of the following is not a primary purpose ofaudit working papers? A To coordinate the examination B To assist in preparation of the audit report C To support the financial statements D To provide evidenceof the audit work performed Difficulty: Medium Source: AICPA 61 Concerning retention of working papers, the Sarbanes-Oxley Act: A Has no provisions B Requires permanent retention C Requires retention for at least years D Requires retention for a period of or less years Difficulty: Medium 62 During an audit engagement pertinent data are prepared and included in the audit working papers The working papers primarily are considered to be: A A client-owned record of conclusions reached by the auditors who performed the engagement B Evidence supporting financial statements C Support for the auditors' representations as to compliance with generally accepted auditing standards D A record to be used as a basis for the following year's engagement Difficulty: Medium Source: AICPA 5-36 Chapter 05 - AuditEvidenceand Documentation 63 Although the quantity, type, and content of working papers will vary with the circumstances, the working papers generally would include the: A Copies of those client records examined by the auditor during the course of the engagement B Evaluation of the efficiency and competence of the audit staff assistants by the partner responsible for the audit C Auditor's comments concerning the efficiency and competence of client management personnel D Auditing procedures followed and the testing performed in obtaining auditevidence Difficulty: Medium Source: AICPA 64 The permanent file section of the working papers that is kept for each audit client most likely contains: A Review notes pertaining to questions and comments regarding the audit work performed B A schedule of time spent on the engagement by each individual auditor C Correspondence with the client's legal counsel concerning pending litigation D Narrative descriptions of the client's accounting procedures and controls Difficulty: Medium Source: AICPA 65 Working papers that record the procedures used by the auditor to gather evidence should be: A Considered the primary support for the financial statements being examined B Viewed as the connecting link between the books of account and the financial statements C Designed to meet the circumstances of the particular engagement D Destroyed when the audited entity ceases to be a client Difficulty: Easy Source: AICPA 5-37 Chapter 05 - AuditEvidenceand Documentation 66 In general, which of the following statements is correct with respect to ownership, possession, or access to working papers prepared by a CPA firm in connection with an audit? A The working papers may be obtained by third parties where they appear to be relevant to issues raised in litigation B The working papers are subject to the privileged communication rule which, in a majority of jurisdictions, prevents third-party access to the working papers C The working papers are the property of the client after the client pays the fee D The working papers must be retained by the CPA firm for a period of ten years Difficulty: Easy Source: AICPA 67 Confirmation would be most effective in addressing the existence assertion for the: A Addition of a milling machine to a machine shop B Payment of payroll during regular course of business C Inventory held on consignment D Granting of a patent for a special process developed by the organization Difficulty: Medium Source: AICPA In preparing for an auditof the retail footwear division of a major retail organization, the auditor gathered the following information about the organization's stores: 5-38 Chapter 05 - AuditEvidenceand Documentation 68 An auditor performs analytical procedures that involve comparing the gross margins of various divisional operations with those ofother divisions and with the individual division's performance in previous years The auditor notes a significant increase in the gross margin at one division The auditor does some preliminary investigation and also notes that there were no changes in products, production methods, or divisional management during the year Based on the above information, the most likely cause of the increase in gross margin would be: A An increase in the number of competitors selling similar products B A decrease in the number of suppliers of the material used in manufacturing the product C An overstatement of year-end inventory D An understatement of year-end accounts receivable Difficulty: Hard Source: IIA 69 Management is concerned about the lower level of profitability in the Mid-Central Region Which of the following would be a reasonable possible explanation(s) of the lower profitability for the Mid-Central Region? I The lower number of stores in the Mid-Central Region II Sales employees are not as productive in generating sales as those in other regions III The Mid-Central Region has a lower gross margin A I only B II only C II and III only D I, II and III Difficulty: Medium Source: IIA 70 Based on the previous information, which of the following preliminary conclusions can the auditor use as a basis for further investigations? A Sales per store are directly related to the size of the store B Sale clerks are less productive in larger size stores C Gross margin is directly related to the size of the store D Average square feet of store correlates with the number of stores in the district Difficulty: Medium Source: IIA 5-39 Chapter 05 - AuditEvidenceand Documentation 71 Which of the following statements is not correct regarding the auditor's further analysis? A The Mid-Central Region has fewer average full-time equivalent employees per store than the other regions per store B The other regions all generate higher sales per square foot than the Mid-Central Region C The Mid-Central Region has the highest average wages per full-time equivalent employee D The largest contributor to total corporate profits is the Southwest Region Difficulty: Medium Source: IIA 72 Management has centralized purchasing and uses a model based upon previous year's sales with adjustments for trends in the market place, e.g., the trend to more casual shoes A staff auditor has suggested that the centralized purchasing may be one of the reasons for the lower level of profitability in the Mid-Central Region Which of the following would be the best single audit procedure to address the staff auditor's assertion? A Take a sample of receiving documents at stores and trace to purchase orders to determine the length of time between the purchase and delivery of the goods B Interview store managers in the Mid-Central Region to determine their attitude toward centralized purchasing C Perform an inventory count at selected stores in the Mid-Central Region and determine if adjustments are needed to the perpetual records D Perform a product-line analysis of sales and purchases in the Mid-Central Region and compare with other regions Difficulty: Hard Source: IIA 73 What type of transactions ordinarily have high inherent risk because they involve management judgments or assumptions in formulating accounting balances? A Estimation B Nonroutine C Qualified D Routine Difficulty: Medium 5-40 Chapter 05 - AuditEvidenceand Documentation 74 Assertions with high inherent risk are least likely to involve: A Complex calculations B Difficult accounting issues C Routine transactions D Significant judgment by management Difficulty: Medium 75 The date on which no information may be deleted from audit documentation is the A Client's year-end B Documentation completion date C Last date of significant fieldwork D All of the above are incorrect in that no information may ever be deleted from audit documentation Difficulty: Medium 76 In evaluating an entity's accounting estimates, one of the auditor's objectives is to determine whether the estimates are A Prepared in a satisfactory control environment B Consistent with industry guidelines C Based on verifiable objective assumptions D Reasonable in the circumstances Difficulty: Hard Source: AICPA Essay Questions 5-41 Chapter 05 - AuditEvidenceand Documentation 77 Analytical procedures are substantive procedures that may be used to provide evidence about specific accounts and classes of transactions a Describe three major types of comparisons the auditor might make in performing analytical procedures b At what stages of the audit are analytical procedures performed and what purpose they serve at each stage? a Comparisons made in performing analytical procedures include (only three required): • Comparisons with prior years' data • Comparisons with budgets and forecasts • Comparisons with industry statistics • Comparisons with nonfinancial data • Comparisons of predictable relationships based on past history b Analytical procedures may be performed: During planning to identify items that require more audit attention Throughout the audit as a substantive procedure for accounts or classes of transactions At the conclusion of the audit for an overall review of the audited financial statements Difficulty: Medium 78 Audit working papers are an integral part of an examination in accordance with generally accepted auditing standards a Describe three major functions of the audit working papers b Distinguish between the permanent working paper file and the current working paper file a The functions ofaudit working papers include (only three required): • Provide a means of assigning and coordinating audit work • Aid in review of the work • Provide support for the auditors' report • Document compliance with generally accepted auditing standards • Aid in planning and conducting future audits b The permanent file is used to organize working papers of continuing audit interest over a number of years The current file contains the administrative andevidence working papers for the year under examination Difficulty: Medium 5-42 Chapter 05 - AuditEvidenceand Documentation 79 The following is an audit working paper prepared by an assistant on the Williams audit: Prepared by _ Reviewed by _ Required: Prepare a list of review points as the preparer of this working You may assume that any other working papers referred to appropriate You will receive credit for proper points you bring up and lose credit for improper ones and omissions 5-43 Chapter 05 - AuditEvidenceand Documentation The working paper's deficiencies include: • "prepared by" is not initialed ("Rev by" isn't either, but since we are still performing the review it need not be) • Title of schedule is wrong, this is not a bank confirmation, it is a bank reconciliation • The by Balance per Bank is incorrect for two reasons First, the balance would not be in the general ledger Second, the balance per bank should be agreed to either a bank confirmation, bank statement, or both • The bank service charge should be added, not subtracted • Concerning balance per books, two things are wrong First it is not footed in that the ƒ is missing Second, it does not foot properly • The tickmark ;is incorrect relating to the deposit in transit If it was on the 12/31/0X bank statement, it would not be a deposit in transit • The description is not correct since it should be recorded as a cash receipt as of 12/31/OX if the bank collected it prior to year-end It is handled on the reconciliation properly, but the final comment is wrong Difficulty: Hard 5-44 ... Documentary evidence about occurrence of a transaction D Part of the client's accounting system 5- 5 Chapter 05 - Audit Evidence and Documentation 25 The auditors of Smith Electronics wish to limit the audit. .. accounts, and in the final review of the audited financial statements 5- 8 Chapter 05 - Audit Evidence and Documentation 38 Which of the following is a basic approach often used by auditors to... B Lack of sufficiency C Lack of accuracy D Lack of availability Difficulty: Medium 5- 27 Chapter 05 - Audit Evidence and Documentation 31 In auditing an asset valued at fair value, which of the